Tuesday, March 06, 2012

Debt-to-income revisited

Private sector economists met with Finance Minister earlier this week to discuss the state of the economy in preparation for the March 29 budget. According to news reports, it was a pretty upbeat session. The major concerns of the past year – the European debt crisis, the recession in the U.S., a sluggish economy, have all but disappeared. However, when the discussion turned to the housing market, there was no consensus. No surprise there. Economists predict the market will go in a certain direction and the market does something else. There was concern for the condo market and amortization periods, probably because those are all that’s left to be concerned about. And of course, interest rates are still low, which continues to fuel warnings about household debt.  So the government has once again warned Canadians about taking on too much debt in terms of their residential mortgages.

The Bank of Canada Review, which focuses on household debt and changes in the value of Canadian's single-most important asset -- their homes – said, “Household indebtedness is not unique to Canada.  The review also said the Canadian housing market has not exhibited the excesses seen in other countries, where severe economic disruptions have occurred in recent years.”

Do we really have something to worry about?

Finance Minister Jim Flaherty said recently, "People are paying down their consumer debts more than they used to and that's a good thing in terms of personal and family responsibility because credit card debt, as we all know, is very expensive debt in terms of interest rates. On the housing market, we're seeing some moderation of late in good parts of residential mortgage markets.”

So let’s take a look at debt and income. Debt includes all debt and unsecured debt in the form of credit cards and unsecured lines of credit and loans. Secured debt or using the equity in a home is the most common and the cheapest money, whether refinancing for debt consolidation or for home improvements.   While it’s true that by increasing a mortgage using low interest rates puts the home owner at risk if rates should climb, a survey by the Canadian Association of Accredited Mortgage Professionals (CAAMP) found that borrowers can easily cover an increase in monthly payments.

Unsecured debt is more of a worry since it has been a major contributor to the pace and the growth of household debt – a point that mortgage brokers have tried to get across and was finally confirmed by Statistics Canada. Interestingly, since the government and the Bank of Canada started warning consumers last year to stop increasing their household debt, the response has been positive. Canadians started paying down their credit cards and loans. The latest national credit trends report from Equifax Canada said the average credit card debt fell in 2011 by 3.4 per cent. The Equifax report also found a "remarkable" improvement in consumer delinquencies, or non-payments, and bankruptcies in 2011 from record numbers in the prior two years.

Now, let’s take a look at income. If income goes up and debt remains constant the debt-to-income ratio decreases. It’s a shock to hear the media reporting that the consumer debt-to-income ratio is 154%, however; the reason for that is incomes are not rising. So, in reality, it’s an income issue more so than a debt issue.

But now with news that the economy will grow modestly in 2012 and 2013, and manufacturing set to grow, incomes will likely follow suit. Despite rumblings that public sector jobs will be affected in the upcoming budget, Finance Minister Jim Flaherty has enough awareness of the effects of job losses on the Canadian economy that he will not put its tenuous growth at risk.

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